On November 24, 2021, the European Council adopted two proposals that are part of the digital finance package — the ‘Regulation on Markets in Crypto Assets' (MiCA) and the ‘Digital Operational Resilience Act' (DORA). Initially proposing the digital finance package in September 2021, the EU Council recognizes that “lack of an overall Union framework for crypto-assets can lead to a lack of users’ confidence in those assets, which could significantly hinder the development of a market in those assets and can lead to missed opportunities in terms of innovative digital services, alternative payment instruments or new funding sources for Union companies.”
The package aims to create a unified approach for crypto in the EU, that ensures consumer and investor protection throughout member states, rather than allowing a fragmented approach to form in which standards differ from nation to nation.
That package also contains the Council’s overall strategy related to crypto-asset regulation and a proposal on distributed ledger technology. The purpose of MiCA is to create a regulatory framework for the crypto-assets market that supports innovation and draws on the potential of crypto-assets in a way that preserves financial stability and protects investors. Merkle Science published a guide to EU’s crypto regulation, read insights from MiCA here.
Key highlights from the negotiation mandate for MiCA Regulation:
The negotiation mandate for MiCA creates a framework for the issuance and services related to transferrable crypto-assets, mainly calling on firms to be transparent in their operations. MiCA also states that any legislation adopted in the field of crypto-assets should be specific, future-proof, and be able to keep pace with innovation and technological developments. Recognizing that the crypto industry is evolving at a rapid pace, the EU Council stated crypto-assets and distributed ledger technology should be defined broadly. A broad definition will allow MiCA to bring within its purview those crypto-assets that despite having financial use are not covered by the European Union legislation on financial services, (EU banks and financial laws), such as for example,crypto-assets that are being used for investment or as a means of exchange.
Certain exclusions were also included in the negotiation mandate. Crypto-assets issued by central banks acting in their monetary authority capacity or by other public authorities will not be subjected to the MiCA framework covering crypto-assets. Additionally, transactions between global organizations like International Money Fund and the Bank for International Settlements will also fall outside the scope of MiCA.
Crypto-assets that are unique and not fungible with other crypto-assets, including digital art and collectibles, will also fall outside the scope of the framework. Similarly, the framework will not apply to crypto-assets representing services or physical assets that are unique and not fungible, such as product guarantees or real estate. Crypto-assets that are offered for free or as rewards may also be exempted from MiCA regulations.
Further, the negotiation mandate made the distinction between three sub-categories of crypto-assets. The first subcategory of crypto-assets is assets-referenced tokens. These tokens aim at maintaining a stable value by referring to any value or right, or combination thereof, including one or several official currencies. Asset-referenced tokens may also include algorithmic stablecoins, such as Meta’s (Formerly Facebook’s) Diem, that aim at maintaining a stable value in relation to an official currency of a country or one or several assets.
The second sub-category of crypto-assets known as e-money tokens are crypto-assets that reference only one official currency of a country. The function of such crypto-assets will be very similar to the functions of electronic money. They will be used as surrogates for coins and banknotes and will be used for making payments or as a store for value.
Under MiCA, depending on the design and structure, stablecoins may be considered either asset referenced tokens or e-money tokens. While e-money tokens maintain a stable value against one single fiat currency, asset-referenced tokens may do so by reference to multiple fiat currencies, commodities, crypto assets, or a combination thereof.
The third sub-category of assets includes those crypto assets that do not fall under asset-reference tokens or e-money tokens. This criteria covers crypto-assets such as utility tokens. Utility tokens are crypto assets that are issued to provide access to a good or service supplied by the issuer of that token.
When crypto assets falling under the third category are issued, issuers will have to submit white papers containing mandatory disclosures such as the rights and obligations attached to the crypto assets. The information contained in the white paper should be clear, fair, and not misleading.
Obligations placed on token issuers
Asset-referenced tokens - To ensure the proper supervision and monitoring of offers to the public of asset-referenced tokens, issuers of asset-referenced tokens will be required to have a registered office in the EU. Before offering asset-referenced tokens to the public or listing them on trading platforms, issuers of such asset tokens have to get the crypto-asset white paper approved by a competent authority. Amongst other things, the white paper should include information on the stabilization mechanism, on the investment policy of the reserve assets, on the custody arrangements for the reserve assets, and the rights provided to holders.
The authorization requirement does not apply when tokens are issued to qualified investors or when the offer to the public is below certain monetary thresholds. Additionally, credit institutions authorized under the EU’s capital requirements directive will not need another authorization under MiCA to issue asset-referenced tokens.
Issuers of asset-referenced tokens are required to have robust governance arrangements in place. The management body of such issuers and their shareholders should have good repute, sufficient expertise, and should be fit and proper for the purpose of anti-money laundering and combatting the financing of terrorism. To address the risks to the financial stability of the wider financial system, issuers of asset referenced tokens will be subject to capital requirements proportionate to issuance size.
E-money tokens - Unlike, issuers of asset-referenced tokens, issuers of e-money tokens should be authorized either as a credit institution under Directive 2013/36/EU or as an electronic money institution under Directive 2009/110/EC. Therefore, in addition to MiCA regulations, issuers of e-money tokens will also have to be compliant with the revised Electronic Money Directive. Issuers of e-money tokens are also required to produce a crypto-asset white paper and notify their competent authority.
Further, since e-money tokens have to be treated at par with e-money, MiCA seeks to ensure that holders of e-money tokens will be given the same level of protection as e-money holders. This essentially means that e-money token holders will have to be granted a right to redeem their token at par, and this right will be protected by funds safeguarded by the issuer. It is important to note that no such obligation applies to the issuers of asset-referenced tokens.
Crypto asset service providers
Crypto-asset services will only be provided by legal entities that have a registered office in a member state and that have been authorized as a crypto-asset service provider by the competent authority of such state. Though the users are still allowed to receive services from firms situated outside the member state, they are required to do so at their ‘own initiative’; however, if a third-country firm specifically solicits clients or potential clients in EU, then it has to seek authorization as a crypto-asset service provider.
Crypto-asset service providers will be required to provide their clients with clear and fair information about their business structure and services, in addition to warning them about the risks associated with crypto-assets. They will have to make their pricing policy public and establish a complaint handling procedure. They will have to put in place sound internal control and risk assessment mechanisms as well as adequate systems and procedures to ensure integrity and confidentiality of information received and to comply with AML/CFT obligations under the Directive (EU) 2015/849. Crypto-asset service providers will also be required to have appropriate arrangements to keep records of all transactions, orders, and services related to crypto-assets that they provide.
Key highlights from the negotiation mandate for DORA:
The negotiation mandate for DORA seeks to create a regulatory framework to cover digital operational resilience, ensuring that companies can withstand all types of information and communication technology risk-related disruptions and threats. DORA establishes concrete cybersecurity obligations, regulates contractual terms, describes the prudential role financial regulators have on cybersecurity, and creates requirements around supply chain risk management. Further, it also seeks to create a uniform reporting framework for incidents leading to cybersecurity breaches also necessitates setting out certain key principles to guide financial entities' management of third-party risk, particularly when using third-party service providers to support their critical or important functions.
Now, the EU Council will enter into negotiations with the Parliament on both MiCA and DORA. Once they reach a provisional agreement, both institutions will formally adopt the regulations.
How Merkle Science can help?
With the EU Council strengthening in AML/CFT regime and gearing up to ensure strict implementation of its guidelines, crypto-asset service providers and token issuers should proactively put robust compliance frameworks in place. Merkle Science’s highly customizable and easy-to-use platform provides near real-time detection of blockchain transactional risks. Our predictive cryptocurrency risk and intelligence platform set the standard for the next generation of financial safeguards and criminal detection. Merkle Science proprietary Behavioral Rule Engine allows crypto businesses to tailor the tool according to their risk policies based on the recent changes so that businesses may stay ahead of emerging illicit activities and fulfill their local compliance obligations.